Ask Yourself…2Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewDo you want to protect the value of yourestate from shrinkage due to the payment ofestate settlement costs at your death? Do you want your family to have fundsavailable to replace your earning power atyour death?Do you want to make plans to provide foryour children from a prior marriage at yourdeath? Will your heirs need cash to continueoperating a family business at your death?Do you want to make a substantial gift tocharity, without depleting the size of yourestate that passes to your heirs?Would you like the value of insuranceproceeds on your life to pass to your heirstransfer tax free and outside of probate?If the answer to one or more of these questions is "yes,“ then an irrevocable life insurancetrust may be the solution.?
What Is a Trust?3Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewThe word "trust" is applied to all types of relationships,both personal and business, to indicate that one personhas confidence in another person.For our purposes, a trust is a legal device for the management of property. Through a trust,one person (the "grantor") transfers the legal title to property to another person (the"trustee"), who then manages the property in a specified manner for the benefit of a thirdperson (the "trust beneficiary"). A separation of the legal and beneficial interests in theproperty is a common denominator of all trusts.In other words, the legal rights of property ownership and control rest with the trustee, whothen has the responsibility of managing the property as directed by the grantor in the trustdocument for the ultimate benefit of the trust beneficiary.A trust can be a living trust, which takes effect during the lifetime of the grantor, or it can be atestamentary trust, which is created by the will and does not become operative until death.In addition, a trust can be a revocable trust, meaning that the grantor retains the right toterminate the trust during lifetime and recover the trust assets, or it can be an irrevocable trust,meaning that the grantor cannot change or terminate the trust or recover assets transferred tothe trust.
What Is an Irrevocable Life Insurance Trust?4Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewWhile there are many different types of trusts, our focus is on an irrevocable life insurance trust… a trustwith the primary purpose of owning a life insurance policy in order to remove life insurance proceedsfrom the taxable estate and, as a result, avoid paying estate taxes on those proceeds.The objective of an irrevocablelife insurance trust is toremove life insuranceproceeds from the taxableestate so that the beneficiariesreceive the entire amount,undiminished by estate taxes.While life insurance proceeds usually pass to the beneficiary free of federal income tax, they are subjectto federal estate tax if included in the insureds estate at death. If the estate exceeds a certain value,this means that a portion of the life insurance proceeds, if included in the taxable estate, could go topay federal estate taxes instead of being available to the beneficiaries:If youdie in:And the value of yourestate exceeds:Your taxable estate is subjectto tax rates from/to:2013$5,250,000 (as indexedfor inflation)18%/40%
How Is an Irrevocable Life Insurance Trust Funded?5Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewAn irrevocable life insurance trust can be funded either by transferring ownership of an existinglife insurance policy to the trust, or by purchasing a new life insurance policy:While an existing life insurance policy can be transferred to an irrevocable lifeinsurance trust, there are "strings attached." If the gift of an existing life insurancepolicy is made within three years of the grantor/insureds death, the value of thelife insurance proceeds are brought back into the estate for federal estate taxpurposes.Transfer ofexistingpolicy:Assuming the grantor is insurable, it may be preferable to make cash gifts to thetrust, which then purchases a new insurance policy on the grantors life. Since thegrantor/insured never held any "incidents of ownership" in the new policy, theinsurance proceeds should not be included in the taxable estate, even if deathoccurs within three years of the insurance purchase by the trust.Purchaseof newpolicy :In situations where the trust will need to make premium payments, a typical irrevocable lifeinsurance trust arrangement calls for the grantor/insured to make annual gifts to the trust, whichare then used to pay the life insurance premiums.continued on next slide
How Is an Irrevocable Life Insurance Trust Funded?6Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewIn order for those gifts to qualify for the annual gift tax exclusion ($14,000 in 2013), the gifts mustqualify as a “present interest gift”. This can be accomplished by including a "Crummey" withdrawalpower in the trust.A Crummey withdrawal power (the name derives from a court case, Crummey v. Comm.) gives thetrust beneficiary a noncumulative, annual right to demand withdrawal from the trust.Since the beneficiary stands to ultimately benefit from the trust and since a demand withdrawalfrom the trust may affect the grantors decision as to future gifts to the trust, beneficiariesgenerally understand that making a demand withdrawal is not in their best interest.For the demand right to be legitimate, the trustee must provide the beneficiary with notice ofannual trust contributions and provide an adequate amount of time, such as 30 days, for thedemand right to be exercised.If the demand right is exercised, the trustee must deliver the funds to the beneficiary.If the demand right is not exercised, the annual gift is then available for the trustee to usefor premium payment purposes.
An Irrevocable Life Insurance Trust in Action7Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewThe grantor makes an annual gift to theirrevocable life insurance trust sufficient to paythe premiums on the life insurance policyowned by the trust.Grantor TrusteeAnnual GiftsPremiumPaymentsTrustBeneficiary(ies)Crummey Withdrawal NoticeThe trustee provides a notice to the trust beneficiary(ies)of the annual trust contributions subject to withdrawal,qualifying the gift for the annual gift tax exclusion.Assuming the trustbeneficiary(ies) do notexercise theirwithdrawal right, thetrustee then uses thegift to pay the lifeinsurance premiums.DeathBenefitWhen the grantor/insured dies, the lifeinsurance death benefit passes income andestate tax free to the trust.Insurance CompanyAsset DistributionGrantor’s EstateLoansorAssetPurchasesforEstateLiquidityFinally, the trust assets aredistributed to the trustbeneficiary(ies) according tothe terms of the trustdocument.If needed for estate liquidity purposes, the trusteecan loan money to the estate or purchase assetsfrom the estate.
Irrevocable Life Insurance Trust Tax Considerations8Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewIf an existing life insurance policy is given to the trust, the value of the policy is subject to gifttax, but only if it exceeds the annual gift tax exclusion. The value of the policy is generallybased on the policys interpolated terminal reserve value, a value that is usually close to thecash surrender value.If death occurs within three years of giving an existing life insurance policy to the trust, thevalue of the death proceeds will be brought back into the estate for federal estate taxpurposes.Annual gifts made to the trust for premium payment purposes must be subject to theCrummey withdrawal powers in order to qualify for the annual gift tax exclusion ($14,000 in2013). Alternatively, gifts will be subject to the unified federal gift and estate tax, but qualifyfor the lifetime exemption equivalent ($5,250,000 in 2013).The death benefit payable to the trust will not be included in the insureds taxable estate,assuming the insured held no incidents of ownership in the policy at death.Death benefits are generally received free of federal income tax.
Uses of an Irrevocable Life Insurance Trust9Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewIf your estate is likely to face a federal estate tax liability, an irrevocable life insurance trust canreplace funds used to pay the estate tax, without the death proceeds also being subject to theestate tax.An irrevocable life insurance trust can be put to a variety of uses:continued on next slideIf your heirs are likely to need additional estate liquidity after your death, such as to continue afamily business, an irrevocable life insurance trust can provide that liquidity, again without theinsurance proceeds being subject to the federal estate tax.If you want to control how death proceeds are distributed, you can do so through the provisionsincluded in an irrevocable life insurance trust.If you have children from a prior marriage, but want your current spouse to be the primarybeneficiary of your estate, naming your children the beneficiaries of an irrevocable life insurancetrust can provide them with a distribution at your death, rather than at your surviving spouses laterdeath.If you want to leave your loved ones a substantial life insurance estate, an irrevocable life insurancetrust can be used to pass the full value of life insurance proceeds to your heirs estate tax free.
Uses of an Irrevocable Life Insurance Trust10Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewIf you want to make a substantial bequest to a charity, either during your lifetime or at your death,an irrevocable life insurance trust can play a wealth replacement role, with the proceeds from thetrust replacing for your heirs the value of assets given to charity.If you are considering use of an irrevocable life insurance trust, however, it is important that you alsoevaluate the potential drawbacks of this arrangement:Since the trust is irrevocable, you relinquish control of the life insurance policy and annual giftsmade to the trust. In addition, once the trust document is executed, you cannot change the termsor terminate the trust.If the trust contains the Crummey withdrawal provision in order to qualify the gifts to the trust forthe annual gift tax exclusion, a beneficiary may exercise his or her right to demand a withdrawal.There is some expense involved. In addition to possible trustee fees, you should consult with anattorney experienced in estate planning in order to avoid unforeseen tax and distributionconsequences.
Irrevocable Life Insurance Trust Action Checklist11Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust Review(Grantor and Attorney)Draft and execute a trust agreement; name a trustee.(Grantor, Trustee and Financial Professional)Transfer existing life insurance policy to the trust or apply for a new life insurance policy,naming the trustee as policy owner and beneficiary.(Grantor)Make cash gifts to the trust.(Trustee)If applicable, send Crummey withdrawal notices to beneficiary(ies).(Trustee)Pay the life insurance premiums.(Trustee)Upon the grantor’s death, manage the insurance proceeds and make distributions accordingto the terms of the trust.
A Note About Naming a Trustee12Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewThe spouse can be named as trustee, but the attorney may have to include special provisions inthe trust agreement in order to avoid adverse tax consequences. If, however, second-to-die lifeinsurance is used in the trust, the spouse should not be named as trustee.Finally, it is generally recommended that the trustee of an irrevocable life insurance trust not bethe same as the estates personal representative (executor). Reason: Conflicts between the trustand the estate may arise after the grantors death.While an individual or a corporation, such as a bankor trust company, can be named to serve as trusteeof an irrevocable life insurance trust, the insuredmust not be the trustee.Naming the insured as trustee willcause the life insurance proceedsto be included in the insuredstaxable estate!
A Note About The Federal Estate Tax13Protecting Life Insurance Proceeds: An Irrevocable Life Insurance Trust ReviewWhether your estate is actually subject to the federal estate tax will depend on the size of yourestate, the year you die and whether future Congressional action modifies the estate tax rules.